Curve Finance Visually Explained
Automated Market Makers (AMM) are revolutionizing the way we swap cryptocurrencies on blockchain. Without relying on an order book to execute swap transactions, these exchanges work through liquidity pools.
While Uniswap started the AMM revolution, it was not ideal for stablecoins (coins that maintain a stable value) such as the USDT and DAI. Uniswap is coded to maximize the probability that funds are available for transaction at all price ranges, and so, falls prey to the price slippage phenomenon as one asset accumulates disproportionately in the liquidity pool.
This is where the CurveDAO, previously known as the stableswap, comes into action. Curve Finance allows you to autonomously swap your stablecoins for other stablecoins without drastic price slippage. Take an example of the transaction being executed below. The seller is trying to swap $50,000 worth of USDT for DAI, and is considering to use Uniswap for the swap. As you can see, the swap results in the user actually losing about $30.
However, if the user choses to use Curve Finance instead, they are losing only about $4.
Another benefit of using Curve Finance instead of Uniswap is lower transaction fees. When I started using DApps, I was not very enthusiastic about the $10–30 it took to swap on Uniswap back in 2020. Nowadays, the figure is closer to $100–$300.
How does it achieve better efficiency in Stableswaps?
We have looked at the what, now let’s take a look at how Curve Finance achieves this amazing feat. Skip this part if you are not interested in the mathematics of Curve Finance.
Uniswap uses the constant product formula (X*Y=K) to prevent exhaustion in liquidity pools, where X and Y are tokens are K is a constant.
Under ideal conditions, the Automated Market Maker would follow the constant sum formula (X + Y = C) which would result in no slippage and exact 1:1 swaps, but it would result in exhaustion of the liquidity pools early.
The curve algorithm combines the constant product and constant sum formulae. When pools are balanced, the constant sum invariant is used to swap tokens without slippage, but when the pools go out of balance, the constant product invariant is used and slippage comes into effect. A notable point to include is that the Curve pools often use more than 2 pairs of tokens in pools.
Incentives and Success
Designing a good protocol and ensuring its success are two separate things altogether. The problem with stablecoin liquidity pools has been the low rewards relative to investing in other, appreciating assets in the era of massive investments into the crytocurrency and DeFi space. CurveDAO has been able to succeed in spite of the challenges because of their strong incentives towards users.
The protocol charges the swappers a transaction fee and a ‘rebalancing fee’ to minimize deviation from the natural balance of a pool. For liquidity providers, the Curve protocol rewards them with a share of transaction fees, payouts in CRV tokens, partnerships with other projects and rewards in their subsequent tokens, and a cut from the swaps.
With time, Curve Finance has integrated other similarly-priced cryptoasset pools such as the (renBTC, wBTC, sBTC) pools.
Future Prospects
CurveDAO has carved out a profitable piece of the stableoin niche and solved the problems associated with incentivization of providing liquidity in stablecoin protocols. Time will tell how successful and sustainable CurveDAO is.
